SAPIs to promote private equity in Mexico

Author: | Published: 1 Apr 2006

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Private equity investments have boomed in the past several
decades, particularly in the US and other developed nations,
where most private equity investments are concentrated. Latin
America lags far behind. It receives around 1% of global
private equity flows, of which Mexico only receives 10% - by no
means representative of the size and importance of the tenth
largest economy in the world and the leading economy in Latin
America (according to the World Bank). Although private equity
transactions have increased at a steady pace in Mexico over the
last 10 years, they have done so under an outdated and
inadequate legal framework.

Institutional investors seeking an equity participation in a
new high-risk venture require a legal framework that affords
them certainty and security. The main elements of a private
equity transaction, such as shareholder agreements, voting
covenants, transfer restrictions and exit rights, are either
not regulated or are prohibited under Mexican law. This
translates into complicated deal structures, higher transaction
costs and a higher risk profile leading to a higher cost of
funds for Mexican target companies and sponsors.

In December 2005, after four years of on and off efforts to
create a statutory platform designed to govern private equity
investments, including contemplation of a specific private
equity law, the Federal congress of Mexico approved the amended
and restated Securities Market Law (Ley del Mercado de Valores;
the LMV), which contains a specific chapter applicable to
private equity transactions.

Specifically, the LMV contemplates a new type of
corporation, the sociedad anónima promotora de
inversion, or SAPI, which is designed to accommodate
private equity investments, and serve as a transition from a
closely held corporation into a publicly traded company.

Rationale behind the SAPI

The LMV acknowledged the fact that existing Mexican
corporate and commercial laws were ill equipped to accommodate
private equity investments. The response was the introduction
of the SAPI, a new form of limited liability corporation
designed to serve as target company for, and recipient of,
private equity capital.

The chapter of the LMV dealing with the SAPI is structured
on the fundamental legal principal that parties to any
agreement should be free to bargain what they believe is
necessary to carry out the commercial transaction in question.
Although this concept seems inherent to commercial law and
commercial contracts, unfortunately Mexican law often limits
this freedom on grounds of public policy or public order. This
paternalistic view, which is common in other civil law
jurisdictions, is responsible for many provisions that have
historically been obstacles to structuring and executing
private equity transactions.

Acknowledging the importance of allowing parties to freely
negotiate agreements, the LMV establishes a legal regime that
is meant to exempt SAPIs from the application of certain
restrictive provisions of the 1932 General Commercial
Corporations Law (Ley General de Sociedades Mercantiles; the
Corporations Law), including Articles 112, 113, 132, 134 and
198.

As further described below, the LMV provides, among others,
that the shareholders of SAPIs may execute shareholders
agreements, and may freely negotiate investment and governance
arrangements otherwise prohibited or limited under the
Corporations Law.

The SAPI

The SAPI is a limited liability stock corporation. Mexican
stock corporations may be incorporated as a SAPI, or may adopt
the form pursuant to a transformation resolution adopted by its
general extraordinary shareholders meeting.

Although SAPIs are established in the LMV, they are not
subject to the regulation or supervision of the Mexican Banking
and Securities Commission (Comisión Nacional Bancaria y
de Valores). SAPIs are closely held corporations so their
shares need not be registered before the National Securities
Registry (Registro Nacional de Valores) or listed on any stock
exchange.

Regulation by exemption

As a means of accommodating most forms of private equity
investments, and the features and provisions that are
commonplace for such transactions in most developed economies,
the LMV allows the shareholders of a SAPI to negotiate
arrangements dealing with the following principal areas without
regard to the restrictions established in the Corporations
Law:

Classes of shares. SAPIs may issue common
shares, shares with limited or no voting rights, and
preferred shares. The LMV allows for the issuance of limited
voting shares without the need to grant the shareholders a
right to receive preferred distributions, which is a general
equitable principle established in the Corporations Law. The
LMV allows for the issuance of golden shares, casting shares
or similar securities, granting preferential voting or other
rights to their holders.

Voting restrictions. Shareholders may establish
voting restrictions otherwise prohibited under Article 198 of
the Corporation Law. Hence, the LMV would allow shareholders
to covenant to vote or abstain from voting on certain matters
or in certain circumstances. Likewise, shareholders of SAPIs
may assign their voting rights.

Preemptive rights. Shareholders of a SAPI may
waive or assign their preemptive rights to subscribe and pay
capital increases, even before the shareholders' resolution
is adopted approving the relevant capital increase. The
relevant provisions also allow for the implementation of
punitive dilution and other remedies for shareholders
defaulting on their capital commitments or capital
calls.

Transfer restrictions. The LMV specifically
contemplates the right of shareholders to establish lock-up
periods, rights of first refusal, rights of first offer, as
well as tag-along and drag-along rights.

Liquidity/exit. SAPIs are not restricted from
repurchasing their own shares, which in terms of liquidity or
exit allows the shareholders to put their shares to the
actual SAPI. In addition, shareholders of a SAPI may
establish specific registration rights designed to take the
SAPI public, as well as put-and-call mechanisms among the
shareholders.

Non-compete. Subject to applicable competition
law, and other enforceability questions under Mexican law,
shareholders of SAPIs may establish non-compete or
exclusivity covenants.

Dispute resolution. The shareholders of a SAPI
may establish dispute resolution mechanisms, including
mechanisms triggered by fundamental business disagreements
that trigger buy-sell schemes.

The LMV expressly recognizes the validity and effectiveness
of shareholders agreements among the shareholders of a SAPI.
This allows the shareholders to establish their arrangements
without the need to replicate the relevant agreements and
undertakings in the SAPIs by-laws, which are available to the
public through the commercial registry of the company's
corporate domicile.

Minority rights and corporate governance

The LMV establishes minority rights and protections for
SAPIs that are similar to those that apply to publicly traded
companies. Among other rights, the LMV lowered thresholds for
the appointment of directors and statutory auditors from 25%,
under the Corporations Law, to 10%.

One of the drivers behind the creation of the SAPI was to
establish a new form of corporation that could be used by
closely held corporations to transition more smoothly to
publicly traded status. Hence, SAPI's are given the option to
adopt (even gradually) the corporate governance provisions
applicable to publicly traded companies. SAPI's that elect to
adopt the corporate governance standards of listed companies
will be subject to the more stringent governance schemes. Among
others, the LMV specifies the authority and duties of the board
of directors and the chief executive officer of a listed
company, and contemplates certain standards that are novel to
Mexico, such as the standard of loyalty, the standard of
diligence and business judgment rule.

Towards a modern framework

Although some would question the convenience of regulating
private equity and the SAPI through the LMV, which is the
statute governing the Mexican securities market and publicly
listed companies, there is no question that the SAPI is a step
towards creating a modern and dynamic legal framework suitable
for private equity. The idea of regulating by exemption and
eliminating the application of the provisions in the
Corporations Law that have long been identified as obstacles to
the adequate structuring of private equity investments, was
creative and practical, as it will make the SAPI a laboratory
of sorts to determine the necessity and convenience of
maintaining certain restrictions and alleged protections
contemplated in the Corporations Law.

Should the SAPI prove to be a popular and useful vehicle for
private equity, this will reignite calls for a complete
overhaul of the Corporations Law, which many have argued is
really what is required to update Mexican statutes to the
requirements of the 21st century. In any event, Mexican
government officials and legislators should not lose sight that
a new legal framework that essentially brings Mexico up to par
with other countries in terms of corporate law will not alone
attract private equity investment. For such purposes,
government officials need to enact much needed legislation to
open new markets such as energy and transportation, and
implement tax legislation that promotes private equity
investment.

The partners of Creel García-Cuéllar y
Müggenburg would like to thank associates Dina Moreno and
Jorge Montaño for their valuable contributions to this
article.